Capital gain tax implications
Scenario:
My private company owns a property with seven townhouses on it that were being rented to tenants, In March 2017, the property was sold to a property developer (settlement has taken place). It has been sold on an untenanted basis for land value only.
My company will be wound up before June 30, 2017. Its only asset is cash and it has no liabilities at this time (except for the next PAYG instalment and any income tax liabilities that may arise from this transaction). My company has approximately $300,000 of franking credits at this time.
The company purchased the property in 1975 with a house on it. The shareholders (my wife and I had equal shares) lived in the house from 1975 to 1987. In 1987 the house was demolished, and seven townhouses were built. We used one of the townhouses as our principal place of residence from 1987 onwards and rented the remainder to tenants up until early 2017.
In 2006, my wife died, and her shares were transferred under my name (I am currently still the sole shareholder). I continued to live in the townhouse until 2012 after which I moved into a nursing home. At that time, my townhouse also became a rental property.
My questions are: what are the CGT implications of the sale given the various changes in usage over the years? Is there any CGT implication from the change in shareholding in 2006. Can any of the small business CGT concessions be applied in this case (being a rental property business)? Can CGT simply be ignored because the purchase date is prior to September 1985?
Explanation:
There are a number of events that have the potential to affect the CGT status of your company and the assets.
Firstly, upon your wife's death in 2006, you will have inherited her pre-CGT shares as a post-CGT asset with a market value as at her date of death. You will, therefore, hold your original shares pre-CGT and her shares post-CGT. Under Div. 152, rental properties cannot constitute an active asset.
Secondly, the construction of the seven townhouses in 1987 post-CGT on the pre-CGT land of the company has the potential to give rise to the townhouses constituting "composite assets". which are treated separately to the pre-CGT land (s 108-55(2)). The townhouses will have a cost base equal to their original construction price and any increments to their cost base since 1987. While the sale was for the value of the land, it is still necessary to look at what a reasonable apportionment of the sale price to the townhouses should be; it is then necessary to calculate what the capital gain made by the company on the townhouses (as separate assets to the pre-CGT land) will be.
Thirdly, Div. 149 can result in pre-CGT assets of a company becoming post-CGT where there has been a change in the majority underlying interests in the company. Provided that the shares held by you and your wife originally were purely ordinary shares with no differences in your rights, the death of your wife will not have triggered Div. 149.
Given the above:
- the sale of the land will constitute the sale of a pre-CGT asset, which will not be subject to CGT in the company's hands, and
- the sale of the townhouses will constitute the sale of a separate CGT asset. It is necessary to calculate whether there is a capital gain based on a reasonable apportionment of the purchase price (i.e. what is the market value of the townhouses as a separate asset to the land they are on?).
In situation where it is paid out to the shareholder, it will constitute a frankable dividend. However, if the company is put through a formal liquidation process, then the tax-free gain arising from the sale of the land can be paid out to the shareholder by way of a liquidators dividend and retain its tax-free status (Taxation Determination TD 95/10). Note that the capital proceeds from the sale of the pre-CGT land need to be separately recorded in the books of the company. The CGT status of the shares in the company does not impact upon the taxability of the liquidators' dividend.